What is Due Diligence?

The application of ‘due diligence’ is most commonly associated with mergers and acquisitions, although there are a number of aspects of practice development and management where it is equally applicable.  As far as M&A is concerned there are two aspects of due diligence which can be broadly identified as ‘human resources’ and ‘financial’.  Unfortunately, the number of mergers that fail to lie up to the expectations of both parties are testament to the fact that the due diligence process has not been properly carried out.  An accountancy firm’s assets are its client base, the quality of its staff and partner team and the quality of the work done.  In a nutshell, there are only two facts to be established:

• The bona fides of the business
• The bona fides of the people

All too often what happens is that firms adopt a “what you see is what you get” attitude and if everything looks fine they don’t bother to dig too far below the surface.  In an M&A situation this is simply not good enough.  Bringing two firms together entails making fundamental changes to the business and it is vital to ensure that the individual capabilities and personal qualities of the people involved will enhance (rather than detract from or undermine) the future of the combined practices as a cohesive unit. 

A very common example of what can go wrong is the unexpected departure of one or more partners soon after the completion of the merger; made possible because their exit arrangements had not been fully researched, discussed in detail and agreed.  Not only can this prove expensive in terms of equity repayments or other financial arrangements, but it can destabilise the client base and affect the prosperity of the new business.

Then of course there are the unexpected discrepancies between what was believed to be the financial performance of the firm being purchased/absorbed and what it boils down to when the dust settles.  Sometimes it is simply that the figures have not been examined closely enough (and, lets face it, any firm that is looking for a merger is quite likely to have a skeleton or two in their closet that they would rather is not discovered until afterwards); or it could be that a reasonably healthy overall figure is masking the fact that one or more departments is underperforming.  Should this department have been expected to prop up a similarly weak operation in the other practice, the result is hardly likely to enhance the business!

By measuring the profitability and financial performance of each partner and department within a firm it is possible to arrive at a clear conclusion as to whether the required norms of partner behaviour are being complied with and performed to the highest standards required (and compatible with what the mergee requires)

Another area often overlooked is the true state of the firm’s client bank.  In-depth research is vital and should cover:

• Size and Pareto of clients
• Nature of their business (potential fit with existing client base)
• Age and stage of their owners
• Range of needs –v- range of services offered
• Vulnerability

Due diligence is not only required in an M&A situation.  The appointment of a new partner or other key individual should also be the subject of much in-depth research.  It is not simply a matter of checking that the individual has the right experience or qualifications, but that there is a real cultural fit and that their aspirations are in tune with the firm’s growth and development strategy.

Due diligence should, of course, apply to every aspect of practice management and should be front of mind at all times rather than being considered as something that is only relevant to a small part of the firm’s activities.  It is, after all, simply good business practice.